Is it time to bring an investor into your business?
Deciding whether to give up a piece of the company—in exchange for an investment that would accelerate its growth—is a difficult choice that many business owners have to make.
Your decision will depend on the kind of business you are running, your ambitions for it and your prospects of success. Ask yourself: will an investor want to take a risk on you?
Shareholders want to see a solid growth trajectory that will allow them to earn a substantial return on their capital, says Jean-Philippe Pépin, Vice President, Solution Development & Delivery – BDC Advisory Services.
“Investors are going to get a return by raising the valuation of the company and bringing in more money, either through new investments or the sale of the company,” says Pépin, who helps oversee a portfolio of over 1,200 tech clients. “Valuation is significantly tied to your growth rate, among other factors.”
Even with traditional bricks-and-mortar businesses, investors will want to see a good growth rate and path to profitability that bring them dividends and increase the value of the business over time.
There are many financial and non-financial factors that business owners have to take into account when considering an investment versus other financing options.
Pros and cons of debt and equity
More than money: Good investors give access to resources
A key advantage of partnering with an investor is the experience, expertise and connections they can offer your company, says Pépin. “Investors can bring industry expertise and open doors for you to help your company grow faster.”
They also tend to be very patient and flexible with the use of funds and encourage maximizing returns rather than meeting a predetermined repayment schedule. However, institutional funds typically come into an investment with a plan for when and how they want to exit.
The upside is you get more experienced people around your board or management table; the downside is you’ve got a new boss.
The flipside is that you have to sell a percentage of your ownership and future growth in value. Investors also become your partners in the business and will generally provide input on key management decisions.
“The upside is you get more experienced people around your board or management table; the downside is you’ve got a new boss,” says Pépin. “Some would argue that that kind of governance and accountability is really helpful, but it’s not for everyone.”
It is therefore important to carefully consider both the valuation that investors are assigning to your business and whether they will be good business partners in terms of the expertise they offer, their patience with your business plan and how well you will work together.
Debt financing can be used as an alternative to equity
An alternative to seeking an investor is to bootstrap the company using the cash flow it generates to fund its growth. This may not be a viable solution for businesses that need large upfront investments for product development, marketing, staffing and other expenses.
Another option is to borrow money. Pépin says a business loan can be a good option for companies that are generating a steady stream of revenue or have assets on which to secure a loan.
With debt financing, you don’t have to give up ownership and lenders don’t typically get involved in management decisions as long as you are repaying your loan and meeting your agreed milestones.
Here gain, you should proceed with caution, evaluating not only the interest rate being offered, but also the terms and conditions of the loan and what kind of relationship you will have with the lender, Pépin says. “Set the right expectations for one another up front.”
Mixing debt and equity can be a good option
One option is to use both debt and equity financing. For example, you could use loans to help finance operations between equity financing rounds. Or, you could use loans to fuel your growth and then take on an investor when the company’s equity can be sold at a higher valuation.
Lenders don’t want you to do anything that would risk loan repayment and investors don’t want you to do anything that would limit growth.
However, Pépin warns investors may shy away from your company if you are carrying too much debt because of concerns you may end up using their investment to pay off loans or sacrifice growth to repay the money.
“Lenders don’t want you to do anything that would risk loan repayment and investors don’t want you to do anything that would limit growth.”
Consider different scenarios
When considering whether to partner with an angel investor or turn to another financing source, Pépin recommends you identify “what you must have, what you want to have and what you’re willing to trade.”
Your goal is to find the optimal mix both in terms of type and amount of financing to fuel your company’s growth throughout its journey and ensure you reap the benefits of your hard work.
“Test different scenarios to understand the real cost difference—both financial and non-financial—between funding options, now and over your business’s life cycle.”
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